Why Governments Make Poor Speculators

Unlike Robert Citron, Gordon Brown's misstep didn't hurt him. This is probably because he didn't actually lose money, but rather caused the government to miss out on a handsome profit opportunity that few people noticed. Brown went on to become Britain's prime minister.

In another time and another place, the state of West Virginia and its local governments were blindsided by steep losses in a fund run on their behalf that pooled idle cash for combined investment. The state investment board managing the pool had a wild west mentality which governments investing in the pool appreciated so long as they were getting returns that were far above market interest rates. But the party ended in 1987 when interest rates rose abruptly and the pool managers got caught flat-footed. Instead of owning up to the losses, they lied and doubled down by borrowing money to speculate even more to make up the losses. At one point they had borrowed $11 billion against the pool whose value was only $2 billion. It didn't work.

The state treasurer who oversaw the pool was impeached.

By now you must be wondering whether attempts at speculation by governments might be a reliable contrary indicator. For those unfamiliar with this term, it refers to purchases or sales made by market participants who are regarded as being especially feckless, so much so that their purchases or sales are taken to be a sign that one should do the opposite. Gordon Brown's gold selling spree turned out to be a nearly perfect contrary indicator. Buying gold from Brown at around $250 a ounce in 1999 and holding it would become one of the best trades of this century so far. Likewise, betting that interest rates would rise when Robert Citron bet they would stay the same or fall would have at first tested your liquidity and your resolve, but in the end richly rewarded you. The same might be said of the West Virginia debacle.

Which brings me to the suddenly proliferating idea that governments ought to set up Bitcoin reserves. Newly elected President Donald Trump has spoken favorably about establishing a federally funded Bitcoin reserve. A Texas legislator is proposing that the state have one, too. As the momentum has built in anticipation that large new buyers in the form of governments will enter the Bitcoin market, the price of Bitcoin recently hit record highs above $100,000. Where were those governments when Bitcoin surpassed the lowly price of $500 in 2016? Or when it surpassed $1,000 in 2017 reaching above $17,000 before the year was out?

Governments weren't interested then because Bitcoin seemed risky back then. But, of course, risk is relative to price. If you buy when the price is low, there is less room between you and zero. But investors tend to run in herds toward the latest thing that's going up. Whatever you think of Bitcoin, there is a lot more room between the current price and zero than there used to be. And there is a much bigger public mania surrounding it now than back in 2016 or even 2017. By the way, public mania over a particular investment is another one of those contrary indicators.

While I am no gold bug, it is worth noting that if you get stuck with physical gold after a price crash that wrings out much of the premium that investment demand creates, there is intrinsic value left. Gold has many industrial purposes (electronics of all kinds, dentistry, aerospace, glass that reflects sunlight) and, of course, it is always in demand by those making and selling jewelry. The same cannot be said for exotic leveraged interest rate derivatives sold by Wall Street investment banks. Nor can one make Bitcoin into into rings, bracelets or plating for high-quality electrical connectors.

So, I'm asking myself whether the Trump administration and the state of Texas will go down in the annals of contrary indicator history as calling at least an important top in Bitcoin (followed by the inevitable crash). Economist John Maynard Keynes is reputed to have said that the market can remain irrational longer than you can remain solvent. Bitcoin may indeed be headed to someplace closer to the Moon in the short run. But I suspect that gravity has not been repealed on Earth or in financial markets and that this moment or one coming up shortly will put the timing of the establishment of a U.S. government Bitcoin reserve in the history books—because of the crash that follows.

1. S. The only country that I know of that has established a Bitcoin reserve is El Salvador where Bitcoin is legal tender. El Salvador just recently concluded a $1.4 billion loan agreement with the International Monetary Fund, and the IMF cautioned the government to limit its purchases of Bitcoin.
2. P. S. I own no investment that will benefit from price movements either up or down from any of the investment vehicles mentioned in this article. Also, I tend to be early (sometimes uselessly early) when predicting market tops—which is why I take Keynes' admonition about staying solvent seriously.

By Kurt Cobb via Resource Insights

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